Illinois Attorney General Lisa Madigan is at it again. She is now dissatisfied with the level of charitable services provided by tax-exempt hospitals in Illinois. To rectify the situation, AG Madigan proposed legislation today that would yank the tax-exemption of tax-exempt hospitals that do not provide sufficient levels of charitable care. Attorney General Madigan can’t revoke federal tax exempt status. So her proposal simply provides for revocation of a noncompliant hospital’s Illinois income tax exemption, property tax exemption, and sales/use tax-exemption. Access to tax-exempt financing would also be denied. For most, the loss of property tax exemption will be the big-ticket item.
One of the central problems facing all hospitals is….
Our very own Jack Siegel's book, A Desktop Guide for Non-Profit Directors, Officers and Their Advisors: Avoiding Trouble While Doing Good is scheduled to hit the streets before the end of March. The page proofs are in the editing process. Soon the printing presses will be rolling. The Guide will be published as part of the John Wiley & Sons Nonprofit Series, the highly-regarded legal, business, and mangement series devoted to nonprofits. The book is a comprehensive guide to the legal, accounting, and regulatory issues facing nonprofits. It includes sections on organizational structure, director duties, tax-exempt status, charitable giving (including planned giving), insurance, events liability, employment law, property tax exemptions, record retention, nonprofit postal rates, investment policy, fundraising and endowments, and many other topics. As is the case with the Charity Governance blog, it uses a case-based approach, focusing heavily on issues and problems that other organizations have had to cope with. The book will be required reading for executive directors, general counsel, and nonprofit advisors. |
paperwork. While AG Madigan can now add “Helping Patients” to the
lengthy list of advocacy on her Web site (“Safeguarding Children,”
“Advocating for Older Citizens,” “Protecting Consumers”, "Advocating for Women," "Building Better Charities," and "Ensuring
Open and Honest Government” are already there), her 87 pages of legislation only portends
higher administrative and financing costs for tax-exempt hospitals, including
professional fees paid to law and accounting firms. What follows is our initial analysis of the legislation, which is subject to change as more information becomes available.
THE PROPOSAL. Under AG Madigan’s proposal, a tax-exempt hospital would be required to provide full charity care to any uninsured Illinois resident who applies for charity care and has family income equal to or less than 150% of the federal poverty level. These hospitals would also be required to provide discounted care to any uninsured Illinois resident who applies for charity care and has family income of more than 150% but more than 250% of the federal poverty level. The discounted amount is based on a sliding scale, with no bill exceeding between 20% and 35% of the actual cost. In addition, to the extent that services exceed $10,000 in any twelve-month period, the excess must be provided free of charge to this group of residents. According to the Sun Times, in 2005 the federal poverty limit was $9,570 for a single person and $19,350 for a family of four. See L. Rackl, Madigan: Hike Charity Health Care, Chi. Sun Times, Jan. 23, 2006.
Even if a hospital provides charity care to everyone who qualifies and applies for it, the institution would lose its tax-exempt status if it did not furnish charity care at least equal to 8% of the hospital’s total operating costs. In defining care that qualifies against the 8% amount, the law requires that the hospital designate the services as charity care in advance. In other words, the hospital would not be permitted to count write offs of bad debts against the 8% requirement. We should note that in one newspaper account, AG Madigan is quoted as saying bad debts would count toward charity care. See Hospital Charity-Care Bill Unveiled: Not-for-Profits Would Have to Funnel Operating Costs, PJStar.com, Jan. 24, 2006. Yet the definition of "charity care" in the legislation specifically excludes the hospital from recording "charity care" as a bad debt.
Setting aside our policy disagreement with AG Madigan over the proposal, it is not a well drafted proposal. Specifically, it is not clear whether the 8% amount represents an upper limit on the charity care that they must provide, or whether the requirement that care be provided to certain individuals is independent of what would then be an 8% minimum. As we read the statutory language, the 8% number is a minimum, meaning that a hospital would be required to provide services to eligible individuals even if it had satisfied the 8% requirement. Section 15 of the legislation requires hospitals to provide charity care to the qualifying individuals--using the word "must." Section 25 sets forth the 8% number, referring to it as an "aggregate annual charity care obligations." If the two requirements were integrated, we would have expected to have found language providing for the allocation of medical services to low-income individuals when the cap kicks in. We did not find such language.
The legislation does permit hospitals to count their Medicaid shortfall toward the obligation. That is the difference between the amount of Medicaid reimbursement and the actual cost of the services. The bill also would permit hospitals to count the provision of certain out-of-hospital community benefits towards their obligations, but AG Madigan would have to approve these benefits for eligibility.
Not surprising, government hospitals are exempted from the requirements of AG Madigan’s legislation—what's good for the goose isn’t good for the government. Also exempted are critical access hospitals, as designated in accordance with federal law. These are apparently certain rural hospitals.
The provision regarding revocation is anything but clear. A hospital that fails to meet its 8% obligation would first be subject to a penalty equal to the shortfall. The attorney general would then have the power to refer the matter to the Illinois Department of Revenue for "possible revocation" of exempt status. The amendments to the specific taxing statutes suggest that revocation would be automatic, but the "possible revocation" creates an ambigiuity on this point. Although Attorney General Madigan's legislation indicates that the law is intended to better define "charitable," it actually sidesteps that issue when it comes to actual revocation. What standards will apply to the Illinois Department of Revenue's decision to revoke exempt status if revocation is not automatic? Will a good faith effort to comply protect a hospital from revocation? Will Attorney General Madigan issue regulations providing for a determination based on a four or five year moving average? Nobody knows.
PROBLEMS WITH THE PROPOSAL. There are a number of problems with this proposal.
A. FEDERAL TAX-EXEMPTION. Traditionally, the states have looked to federal tax-exempt status for purposes of determining whether an entity is exempt for state income tax purposes. AG Madigan’s legislation deviates from this approach at a time when the United States House of Representatives is already considering whether to redefine the tax-exemption for “charitable” medical institutions. Rather than creating a separate body of law unique to Illinois, why not wait until Congress addresses the question for all tax-exempt hospitals throughout the country?
B. ROLE OF THE ATTORNEY GENERAL. The preamble to the legislation acknowledges that the Illinois Attorney General is the state’s chief law enforcement officer. We would like to know why AG Madigan has decided to enter the realm of making legislative policy as opposed to enforcing existing laws. AG Madigan would argue that she is just asking the legislature to more specifically define the term "charitable" for purposes of Illinois property tax exemption. Certainly the attorney general would be fulfilling her traditional role by asking the legislature to clarify language in existing laws. However, AG Madigan's proposal goes well beyond clarifying the law. Many provisions call for active involvement by the attorney general's office in administering the law. Depending on the exact scope of these provisions, this could easily result in the creation of an administrative hospital authority within the attorney general's office.
C. EIGHT PERCENT IS BIGGER THAN YOU THINK. In Illinois, 8% doesn’t sound like all that much. After all, Illinois residents are used to paying a 9% sales tax. Yet, when the 8% number is measured against existing numbers for tax-exempt hospitals, it becomes a huge number. The Chicago Sun-Times ran an article showing how Chicago-area hospitals would fare under the proposal. Most currently devoted less than 1% of their operating costs to charitable care according to a Sun-Times table. We decided to look at the most recent tax returns for 10 of the listed hospitals. We acknowledge that there are a lot of problems with our analysis, but on a very rough basis, AG Madigan’s proposal would cause eight of ten hospitals in our sample to run a deficit (or increase an existing deficit). Of course, we don’t know the operating margins for these hospitals, but we suspect they are very small. The take-away point. How can you reasonably ask a hospital that is already operating at a deficit to increase the services it gives away? Or more practically, how can you use a formula for calculating mandatory free services that does not take into account the impact of providing those services on an individual hospital's cost structure or solvency? It is one thing to demand free services from an institution with a large and growing endowment, it is quite another to demand it of an institution that is already operating at a deficit.
Click here for our financial analysis to date. The Illinois Hospital Association indicates that the operating margin for Illinois hospitals is 1.6%. That indicates very high costs per dollar of revenue. We fully acknowledge our analysis is "back of the envelope, but it demonstrates that although 8% may look like a relatively small number, when it is placed in the context of a particular economic model, it can be quite significant. Ultimately, this sort of analysis will depend on the relationship between fixed and variable costs.
D. IMPACT OF FINANCING. AG Madigan’s proposal places significant new burdens on tax-exempt hospitals. With this proposal in place, these hospitals will have trouble accessing the capital markets for financing. We can only wonder how long it will take for Moody's and S & P to adjust the credit rating of these institutions. The proposal also has already probably caused a decline in the value of outstanding bonds, potentially hurting many investors.
E. ADDITIONAL FOR-PROFIT CONVERSIONS. We are not hospital economists. Nor do we follow the industry on regular basis. However, we could certainly see a number of tax-exempt hospitals selling their assets to for-profit hospital systems. These conversions have been going on for at least two decades, so for-profit providers may have already "cherry-picked" the "well run" tax-exempt hospitals. However, to the extent there were holdouts, AG Madigan's proposal could be the straw that breaks the camel's back. The overall affect of additional cherry picking would be to reduce the services available to low-income individuals in certain communities. If AG Madigan really wants to play this game, she should propose that any additional property taxes paid to a community as a result of a conversion be devoted to health care for low-income individuals.
F. CO-PAY/DEDUCTIBLES. To be honest, we have not read every last page of this legislation. However, we saw nothing in the legislation regarding co-pays or deductibles. The insured person has an incentive to think twice about seeking unnecessary medical care because of deductibles and co-pays. That will not be the case for Illinois low-income residents. As far as we can tell, there really is no incentive on the part of low-income patients to manage their use of medical services.
G. PRIVATE RIGHTS OF ACTION. Does the legislation create private rights of action in patients who claim they were denied charitable care because they were eligible? If so, we could see an active plaintiff's bar develop in this area, particularly if punitive damages are available. Section 40 places enforcement of the law with the attorney general, but that does not necessarily preclude private rights of action.
The cynic in us tells us that this is a sign that AG Madigan (Democrat) is paving the way for a campaign for governor. In fact, we find it very amusing that many rural hospitals would be exempted, but not urban hospitals. That exemption is nothing less than smart politics. “Tax” your friends who are unlikely to vote Republican and court the opposition by providing rural and downstate areas relief—those areas traditionally voting Republican--with a nice exemption.
At the root of AG Madigan's proposal is a dissatisfaction with our current health care system. Rather than coming up with a solution that equitably distributes the cost of providing health care to the uninsured, AG Madigan has arrived at a solution that imposes additional burdens on many institutions that are already strapped for resources. We would expect to see some hospitals that are tax-exempt give up their exemption if this legislation is enacted. We would expect to see other hospitals close their doors.
As our headline indicates, the real winners will be the lawyers and accountants. The law creates a new bureaucracy. That is where lawyers and accountants make their money--showing clients how to deal with the red tape. The last thing our health care system needs is more red tape.
For our readers who are located outside of Illinois, watch out. You can bet other states will be watching what happens in Illinois. As we noted, the big dollar items are in the property tax-exemption, which has already been under attack. Don't be surprised if state legislative bodies give serious, but misguided consideration to AG Madigan's proposal. In the short run, many municipalities may welcome the loss of property tax exemption for large hospitals. In the long run, these communities may pay a bigger price when vital medical institutions close their doors.
Our readers who run other types of Illinois tax-exempt entities better not be too smug. Once hospitals are subject to this legislation, will Attorney General Madigan propose that tax-exempt universities must provide "charity educational services" or lose their tax exempt status? Will Attorney General Madigan require that the Goodman Theatre or the Lyric Opera set aside "charity cultural tickets" or lose their tax exemptions?
Internal Revenue Service - Circular 230 Disclosure: As provided for in Treasury regulations, any advice (but none is intended) relating to federal taxes that is contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.
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